- Washington DC’s office vacancy rate has surpassed 15% for the first time.
- Meanwhile, this recession’s bailout doesn’t appear to expand the footprint of government as other downturns have.
- Without government agencies and related tenants active in the leasing market, the city may not be immune to this downturn in the way that it was to previous recessions.
- Despite the headwinds, some investors are optimistic they can capitalize on the demand in recent years for new or renovated offices.
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Girded by a federal government that has only grown during recent recessions, Washington DC’s office market has appeared unsinkable even in the worst of times.
But amid the twin crises of an economic downturn and a virus pandemic that has forced tenants to rethink how they will occupy the workplace, the city may not be as resilient this time.
Washington DC’s office vacancy rate rose to 15.2% at the end of the second quarter, according to data from CBRE, the first time it has surpassed 15% in the 28 years since brokerage and real estate services firm began tracking the measure and 1.3% higher than it was just six months ago. Past periods of strength, such as during the mid-2000s, have pushed Washington DC’s vacancy to less than half of that.
The real-estate brokerage and services firm Savills, found that the availability rate, which measures both current vacancies and spaces that are expected to become empty in the coming months, has reached even higher, hitting 17.6%.
The federal government and the large constellation of lobbying firms, contractors, and service providers that benefit from federal spending, have previously buoyed the market during dips, but few experts expect those office users to race to the rescue this time.
“In 2009, the government stepped in with stimulus and there was a rapid expansion of government tenancy where it absorbed a whole bunch of vacancy,” said David Lipson, a vice chairman at Savills who leads its Washington DC based public sector services group. “There’s no part of the stimulus now that seems as if it is going to result in a major expansion of government jobs.”
Office vacancies have been building
The roughly 120 million-square-foot Washington DC market’s weakening has been in the making for years.
Vacancy has steadily accrued over the last decade as new office supply has been built. During the past four years alone, about 6 million square feet of new space has been added to the market, according to CBRE research. Those shiny new offices lured away tenants, but left behind vacancies in older office properties that have been harder to fill, adding about 2 million square feet of net vacancy to the market, CBRE found.
“There’s a phenomenon in Washington DC called the ‘muffin top’ where the tops of buildings lease because they have higher ceilings, better views or were newly added onto an existing building,” said Craig Deitelzweig, the president and CEO of Marx Realty, which owns three office properties in the Washington DC market. “The bottom floors linger empty.”
Why past recessions were different for commercial real estate
Past downturns have spurred watershed moments for Washington DC leasing activity, even as other office markets across the country were sent reeling.
The attacks of 9/11, which came just after the dot-com crash spurred a recession, established the Department of Homeland Security, which has since grown into one of the Washington DC region’s largest tenants at nearly 5 million square feet, according to the real estate services and brokerage firm JLL.
Asking rents came tumbling down in places such as Manhattan and San Francisco during that downturn, falling 29% and 49.6% on average respectively, according to JLL. In Washington DC, rents rose during the same period.
In the recession a decade ago, the number of jobs in the city actually swelled by 10%, according to JLL, as government grew rapidly to administer a massive bailout of the financial system and added staff to oversee a tightened regulatory regime. Towards the tail end of that downturn in 2010, 4.3 million square feet of space was absorbed, a record figure, according to CBRE data and vacancy swung from 11.8% to 9.8%, a major tightening of the office market.
Manhattan’s average asking rent fell 38.4% and San Francisco’s dipped 25.0% during the financial crisis, but Washington DC’s only fell by a modest 2.5%, JLL reported.
The market has since stagnated, with average asking rents rising only modestly over the last decade from $51.19 per square foot in 2010 to $58.97 per square foot now, according to CBRE. Rental rates have actually fallen during that period, according to Savills, when factoring in the incentives landlords lavish on tenants, such as periods of free rent and contributions to the costs of building out their office interiors.
The $2 trillion CARES Act, which was passed in March, hasn’t ushered in the same government hiring that has translated into market booms in the past.
“For many government tenants now, it’s a pivot rather than an expansion,” Lipson said.
Despite the headwinds, some investors are optimistic
There are some signs for optimism. Washington DC lost about 337,000 total jobs year over year in April compared to nearly 2 million in New York City, about 1 million in Los Angeles, 630,000 in Chicago, 485,000 in Boston, and 375,000 in San Francisco, according to data from Cushman & Wakefield.
The CARES Act has spurred a surge in spending on lobbying, which in the past has translated into modest upticks in leasing activity, especially for pricey, high-end offices that many firms in that industry prefer.
That’s the kind of demand that Deitelzweig is counting on for his firm’s recent acquisition of 1307 New York Avenue NW, a roughly 125,000-square-foot office building that Marx Realty purchased for a little over $40 million in April.
Deitelzweig said the company plans to invest roughly another $40 million renovating the property, which will be fully vacant by the end of the year.
Marx Realty is aiming to operate the building in a manner akin to a hotel, employing features it has used to reposition other buildings it owns, such as 10 Grand Central, a roughly 430,000 square foot office building in Midtown Manhattan, where it has a doorman and concierge desk, a tenant lounge and outdoor space, and even a signature scent and soundtrack in the building’s common areas.
Nearly a century ago, the building served as a headquarters for the newspaper the Washington Times-Herald, including its printing operations, according to Deitelzweig. Because of that, it features high ceilings in its lower floors that were necessary to house the printing equipment. Deitelzweig said those airy rooms will now help his firm avoid the typical difficulties filling lower level spaces.
“The in-place rents in the building were in the $20s per square foot,” Deitelzweig said. “We’re aiming for the $60s and $70s.”
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